The Consequences Of Letting The Shale Industry Go Bankrupt

It’s no secret that the growth of U.S. shale oil has been a thorn in the sides of both Saudi Arabia and Russia. They have seen their market shares erode as the shale boom made the U.S. the world’s largest producer of crude oil.

But Saudi Arabia’s national oil company, Saudi Aramco, is a single entity that produces 13% of the world’s oil and controls 17% of the world’s proved reserves. That puts them in a very powerful position. They can withhold a lot of oil from the market, or they can flood the market with oil and crash the price.

I have warned many times that Saudi Aramco’s power shouldn’t be underestimated, even as some were suggesting the shale oil had rendered OPEC (which they control) toothless. In an article I wrote in 2016, I observed:

“OPEC is a big reason oil prices fell into $20s earlier this year, and they were a big reason oil prices were at $100 a few years ago. What other organization has the power to move the price of oil so dramatically — both up and down? That is real market power. So they may sometimes behave like a paper tiger. But they are capable of rapidly moving the global oil markets.”

Saudi Arabia should not be underestimated. They started a price war in 2014 that drove oil prices into the $20s. No other single entity could have done that. The strategy temporarily stalled U.S. oil production, and although they did bankrupt a few shale oil producers, the industry proved resilient. So Saudi Arabia switched back to cutting production to prop up prices in 2016, and until recently they had maintained that strategy

But this year’s coronavirus (COVID-19) outbreak has caused an enormous decline in oil demand, putting oil under tremendous price pressure. Saudi Arabia wanted more emergency production cuts in response. They had been working with Russia to enact this strategy.

This time, Russia said “Enough is enough. No more cuts.” So, Saudi Arabia responded by ramping up production. When they did so, we saw a mind-boggling 30% drop in the price of oil overnight.

However, this time Saudi Arabia may succeed where they failed in 2014. They struck at a very vulnerable time. U.S. producers were already reeling from the decline in production, and this now places them under tremendous pressure.

The energy sector is suffering from a triple whammy. The collapse of oil demand, the overall decline in the stock market, and finally – and most importantly – the price war that Russia and Saudi Arabia have started have crushed the U.S. energy sector.

Now I am seeing some sentiment from people that we should just let the industry go bankrupt. I have seen people cite the oil industry’s subsidies, or the fact that too many producers took on too much debt, and that it should therefore be allowed to fail.

Let me make a brief point about subsidies. Recently, President Trump suggested using funds from a program that helps low-income Americans afford heating oil to combat coronavirus. Some Democrats howled at the potential cut in this program.

Well, guess what? As I have pointed out in the past, that’s an oil subsidy. The reality is that the vast majority of oil subsidies in the world are consumer subsidies like this. The people who get angry about oil subsidies are sometimes the same people that complain about cutting these kinds of subsidies — because they don’t recognize them as oil subsidies.

Subsidies aren’t direct payments to oil companies, even though that’s what most people envision. So, they get angry about something they misunderstand.

That’s the first point. But a more important question to ponder is “What are the consequences of letting the U.S. shale oil industry go bankrupt?”

Look, you may think the U.S. oil industry deserves to go bankrupt. You may believe we should all be driving around in wind-powered electric vehicles or riding bicycles. But that’s not the world we live in today.

Should we use less oil? Yes. And we will over time. But right now the U.S. still uses a lot of oil, and we will continue to do so for several years, even as we transition to electric vehicles.

The real consequences of letting the U.S. shale industry fail is to hand global control of oil production back to Saudi Arabia. Millions of Americans will lose jobs, domestic oil production will fall, and our oil imports will soar. Saudi Arabia will then be free to once again withhold production to drive up the price.

Some producers will go bankrupt as a result of the current crash. And those that made really poor decisions should go bankrupt. But letting too much of the industry fail will begin toppling dominoes that will have enormous ramifications on the U.S. economy and on our national security.

Russia is going to make decisions the interest of its domestic oil industry. Saudi Arabia is going to do the same, and it has a powerful instrument with which to do so through Saudi Aramco.

The U.S. must do the same, but there are those in government that seem like they would be glad to see the oil industry go out of business. Unlike Russia and Saudi Arabia, our oil industry has decidedly mixed support from the federal government.

The American economy runs on energy. The energy industry is a matter of national security. We can’t give up control of our energy security to Saudi Arabia. That is the consequence of letting this price war destroy the U.S. oil industry.

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